Published 4:00 am, Saturday, February 24, 2007

When it comes to paying income taxes, eBay's legions of small-time entrepreneurs are on an honor system in which they are supposed to declare their profits to the Internal Revenue Service. Many users, however, ignore the law or are unaware of their obligation.

Now a growing chorus of tax experts is hoping to crack down on the cheating by requiring eBay -- and other online auctions, such as those on Yahoo, Ubid.com and Amazon -- to track users and report their gross sales to the federal government. Armed with such information, the IRS could better seek any taxes owed, potentially reaping millions of dollars in extra revenue for the U.S. Treasury.

But requiring eBay to out its sellers to tax collectors could send a shockwave across its vast online bazaar, where users trade everything from Ferraris to Ugg boots to pepper spray. Paying Uncle Sam could significantly reduce their profits or even make their businesses money-losers.

The latest call for more aggressive tax collection was heard last week at a congressional committee hearing focused on closing the tax gap, the hundreds of billions of dollars in taxes that go unpaid each year. Nina Olson, the national taxpayer advocate for the IRS, spoke of the heavy burden put on the nation by the shortfall and then cited undeclared online sales -- particularly on eBay, given its size -- as part of the problem.

"The IRS must have the tools needed to address under-reporting of this income," said Olson, whose job is to voice taxpayer concerns to the federal government.

EBay, based in San Jose, has 97 million U.S. users, who, in 2006 sold $25.2 billion in merchandise, exceeding the gross national product of many countries. More than 720,000 Americans make their primary or secondary income from the Web site, according to a 2005 study.

How many eBay users pay the taxes they owe on their online earnings is unknown. But experts suspect the percentage is low.

Virtually all tax filers -- 96 percent -- pay what's owed on income that is reported to the IRS by a third party, such as when a bank reports interest earned on a savings account, according to the IRS. However, when a third party doesn't tip off the government, compliance drops dramatically, to below 50 percent.

The remedy, according to many federal officials, is to expand reporting requirements. The question is, which businesses and what kind of income should fall under the rules?

As part of his proposed federal budget for 2008, President Bush made what many believe is the first step to more vigorously collect taxes on online sales. Although vaguely worded, the proposal would require "brokers," or middlemen, to collect taxpayer identification numbers from clients and report their sales of personal property to the IRS on a 1099 form if sales surpass 100 transactions or more than $5,000 annually.

Under current law, eBay and other auction sites aren't considered brokers. But definitions can be changed.

In November, a citizen advisory group for the IRS recommended as much. Expanding the definition to include online auctions, the group said, would open the door to reporting and increased tax compliance.

Paul Heller, chairman of the citizen advisory group, made up of accountants and tax preparers, applauded the president's proposal, but called it so nebulous that it's unclear what kind of businesses he's targeting. Heller, a vice president for JPMorgan Chase, suspects that the provisions are at least partly aimed at Internet sales.

"I have no idea who it would be referring to," Heller said of the proposal, "if not online auctions."

Jennifer Zuccarelli, a spokeswoman for the Treasury Department, declined to name any companies the Bush proposal applies to. All she would say is that the provisions would affect both online and offline commerce, without discrimination as to the medium.

Other than Internet sales, tax experts said that art galleries and consignment stores could be potential targets of the Bush proposal.

Hani Durzy, a spokesman for eBay, insisted that his company would be unaffected if Bush's ideas are enacted as written. EBay doesn't meet the definition of a broker, he said, because it never takes possession of the merchandise its users sell.

In any case, Durzy said eBay doesn't even know whether any given transaction is completed and therefore can't report authoritatively about a user's sales to the IRS.

Simply reporting to the government, he added, would be a financial burden for his company.

David Yaskulka, marketing chairman for the Professional eBay Sellers Alliance, an industry group of more than 500 big eBay sellers, said it wouldn't bother him if eBay reported sales information about its users to the IRS. In his experience, big sellers already pay their fair share.

"Every professional seller I've ever talked to pays their taxes and has no problem with anyone finding out about the level of business they're doing," Yaskulka said.

His concern is that legislation will unfairly target eBay. All sales venues, online or off, should be treated the same, he said.

The next step for the proposed legislation, along with a number of other of Bush budget ideas, is to go through Congress, starting with the House Ways and Means Committee. Members are likely to address the issue during an upcoming hearing on closing the tax gap, tentatively scheduled for mid-March.

Matthew Beck, a spokesman for the committee's Democratic majority, declined comment, other than to say of the Bush proposal, "We certainly take that as a starting point, and we certainly look forward to addressing the tax gap."

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